What is Bankruptcy and How Does it Affect Your Credit Profile?

Updated: June 11, 2024 Author:

Quick Answer: Bankruptcy is a legal process of declaring to creditors that debts cannot be repaid. Once declared bankrupt, details are put onto the Individual Insolvency Register. Records are visible to lenders conducting a credit check. This makes it hard (not impossible) to get new finance approved.

    What is Bankruptcy?

    Bankruptcy is like hitting the reset button on your ‘personal’ finances. Only people can be affected by bankruptcy. Businesses and partnerships are treated as separate entities that use a similar process of liquidation. A person can file for bankruptcy if they feel the level of debts they owe are impossible to repay. To declare yourself bankrupt, it costs £680 (as of Feb 2024) and it should not be paid on your credit card because the credit card company could rightfully claim it was fraudulent as you would have knowingly put £680 on credit with the knowledge it would be included in a bankruptcy filing.

    Rather than selling assets you own for the maximum value you can get yourself to pay down debts, filing for bankruptcy hands over that control to an Insolvency Practitioner. They can insist you sell whatever you have that you don’t have a legitimate reason to need (such as a van for work purposes) and sell for whatever you can get to use the proceeds to repay creditors. It usually means some creditors will get some debts repaid, and others may receive nothing. When lenders see a bankruptcy record on a credit profile/report, it’s indicative of high risk because previous creditors will likely have lost money.

    How Long Does a Bankruptcy Last?

    Bankruptcy lasts for 12 months, after which it becomes discharged provided the person subject to bankruptcy has cooperated with the Insolvency Practitioner. During the first year, borrowing restrictions are in place. You can apply for any amount of finance, but you must declare to the lender that you are subject to an undischarged bankruptcy if the sum you apply for is £500 or more. Only specialist lenders will consider this type of finance agreement.

    After a year, although you can be discharged, you won’t be notified. It can help your future ability to access credit to apply for a free confirmation letter of discharge and provide copies of that letter to credit reference agencies as proof that the bankruptcy is discharged. For mortgage applications, lenders require a “certificate” of discharge. If you used the online service to file for bankruptcy, these are free by emailing the Insolvency Service (discharge.queries@insolvency.gov.uk). For court applications, there’s a £75 fee for paper copies plus £11 per additional copy. (Fees correct at time of publication – Feb 2024)

    Can I be Made Bankrupt?

    Yes. Creditors can petition the courts to bankrupt someone who fails to repay their debts. It is rare as there are other means of enforcing debts without seeking to recover assets. The only time it would make sense for a business to apply to bankrupt someone is if they are confident they can win, and are confident that you have assets with a cumulative resale worth of sufficient value to repay the debt owed and the court fees incurred. Petitioning the court to bankrupt someone in England costs £1,500 + £302. Legal fees for a solicitor to present a strong case proving the debt is owed adds to the cost, which is why it’s rare to be made bankrupt.

    The 3 Ways You Can Become Bankrupt

    1. You can declare yourself bankrupt.
    2. A creditor can apply to make you bankrupt if you owe them more than £5,000. Creditors can band together to collectively meet the threshold to make a person bankrupt.
    3. An Insolvency Practitioner can make a person bankrupt for breaching the terms of an Individual Voluntary Arrangement (IVA).

    If you’re in financial difficulties and being chased for debt, it’s important to know that bankruptcy can be imposed on you. For those with valuable assets and little cash in the bank to repay debts, it’ll be imperative to cooperate with creditors to avoid them petitioning courts for repossession of properties.

    Bankruptcy should be a last resort. Before considering bankruptcy costing £680, it’s worth checking if you’d qualify for a Debt Relief Order (DRO) as an alternative. It works similarly to bankruptcy, costs far less (£90) and lasts a year after which, most debts included in it get written off, and your details are only on the Individual Insolvency Register for 3 months rather than a year. The impact of a DRO on your credit files is just as severe as a bankruptcy though. A Debt Management Plan affects your credit score to a lesser extent, and can still get you 3 to 5 years to repay debts. Bankruptcies and CCJs affect your credit score the most causing a severe drop to your credit score.

    Life After Bankruptcy and the Time Frames Affecting Credit Profiles

    First 12 months after bankruptcy

    The first year of bankruptcy is when restrictions are in place. During this time, any loans or finance agreements (solely or jointly) for sums of £500 or more are subject to declaring an undischarged bankruptcy. It is a criminal offense not to declare an undischarged bankruptcy when applying for finance. During this time, those subject to bankruptcy must cooperate with the Insolvency Practitioner. Part of this will be establishing how much can be repaid towards the debt. How much you can afford to repay is based on surplus income after meeting all reasonable living expenses. A Standard Financial Statement is used by debt services in the UK to work out income and expenditure. This will be used to calculate repayment amounts towards the debts included in the bankruptcy.

    3 years after bankruptcy

    Income Payment Arrangements last for a maximum of three years from the date of bankruptcy. Missing payments won’t automatically trigger a breach, but consecutively failing to pay will. If that happens, the solicitor responsible for collecting payments and distributing them among creditors can apply to the court for an Income Payment Order (IPO), making it mandatory to make these payments. Breaching an IPO can result in the stipulated payments being taken directly from wages. These payments continue for three years, then the only impact of the bankruptcy is the entry on your credit report.  

    6 years from bankruptcy

    Six years is how long it takes for information to come off your credit reports. For bankruptcies, it is six years from the date the bankruptcy begins. Not the date of discharge. This not only applies to the bankruptcy record but all the creditors with negative entries. As such, your credit score should increase after six years. Usually significantly because of multiple records dropping simultaneously.

    Each creditor included in a bankruptcy will (or should have) some money being paid by the Insolvency Practitioner, therefore, the marker used during the six years will be “partially settled”. These also disappear after six years. This is when your new credit life starts.

    What won’t drop are any loans and finance agreements taken out after the bankruptcy. Having a bankruptcy on your credit files does not blacklist you. It just means you’ll be deemed to have a poor credit history. You can still pass a credit check with bad credit, even after bankruptcy.  If you do obtain credit, and fall into the same cycle of not paying, those new finance agreements will continue to report for six years from the date of default. In most cases though, because of the difficulty in accessing finance with a bankruptcy on file, the result after six years is a thin credit file because of a lack of reporting. In terms of no credit vs bad credit, lenders know they’re taking a risk with a  bad credit profile, but with no credit, they can’t do a risk assessment. Both can be barriers to getting finance approved.

    Rebuilding Credit Files After Bankruptcy

    You don’t need to wait until 6 years have passed to start improving your credit score. From the date a bankruptcy is discharged, it’s worth actively working on improving your credit score despite the fact that it won’t make a difference in the near future. The purpose is to maintain positive reporting so that once the negative entries drop after six years, you aren’t left starting with a completely blank slate. Using services like BNPL providers that report to CRAs can help keep your credit file active. As can having mobile phone contracts, mail order accounts, and if you’re a tenant, asking your landlord or estate agent to report your rent payments to the Rental Exchange, or self-report your payments through a partner provider.